Unpaid Taxes Tough to Recover

Judging from his tax returns, Dinh Kim Huynh wasn't getting rich in the manicure business. In 2000, Huynh and his wife claimed taxable income of just $7,578 from their two nail salons in Southern Maryland -- so little that they qualified for a tax credit for the working poor. Their tax bill was $195.

But like millions of American business owners who trade primarily in cash, Huynh was not altogether honest with the Internal Revenue Service. When IRS agents poked around, they discovered four cars in Huynh's name, including a $77,000 Mercedes; receipts for diamonds and Rolexes in a closet at his Waldorf home; and a videotape of Huynh flashing a five-carat ring during the purchase of yet another vehicle at a local Honda dealership, court records show.

Huynh, 57, appears to be an especially bold contributor to the tax gap, the difference between what Americans owe the federal government and what they actually pay. By the most recent estimate, the tax gap is $345 billion. Unreported business income accounts for nearly a third of that amount. According to IRS data, U.S. shopkeepers, mechanics, farmers and landlords will pay less than half the taxes they owe on the returns that must be filed by midnight Tuesday.

The tax gap is becoming a popular target in Washington, where the White House and the Democrats who control Congress are eager to find new sources of cash without raising tax rates. But narrowing the gap would require potentially invasive new reporting requirements and ramped-up IRS audits that would inconvenience honest taxpayers and businesses even as they detect cheaters.

Some ideas under discussion: Force credit card companies to report the flow of funds to individual businesses, from the corner dry cleaner to online auctioneers who use eBay. Require stock brokers to report the purchase price when people sell stock. And create tax-withholding arrangements in industries that use independent contractors, such as hair salons, travel agencies and construction sites.

The U.S. Chamber of Commerce and other business groups say many of the proposals would burden law-abiding citizens while doing little to tackle the most significant component of the tax gap: small operators who deal directly with the public and are paid primarily in cash .

Nina E. Olson, the IRS's national taxpayer advocate, acknowledges that reducing the gap would be painful for the innocent as well as the guilty.

"It's going to take discipline," she said. "Congress has said, 'collect the tax gap, collect the tax gap.' But can you stomach the complaints when people actually have to pay what they haven't paid before?"

"It's going to cause a lot of screaming," said economist Mark Zandi of Moody's Economy.com.

For the past four decades, voluntary compliance with U.S. tax laws has held relatively steady, varying from 81 to 84 percent, according to the Government Accountability Office. But the gap's size in dollars has grown with the economy, jumping from about $95 billion 15 years ago to nearly four times that today.

To some lawmakers, that looks like easy money. But the gap is notoriously stubborn. Former IRS executives identified just one big success: In 1985, taxpayers were told to name dependents on whom they wanted to claim deductions and list their Social Security numbers. "Lo and behold, we lost five million-plus children who never existed," said Donald C. Alexander, IRS commissioner at the time.

What were 5 million children worth to the IRS? About $5 billion -- peanuts compared with the overall tax gap. Reformers face the same problem now. Ideas offered by the White House in February, including the credit card measure, would collect only about $30 billion over the next decade.